Don’t Forget the QPRT – Taking Another Look at Qualified Personal Residence Trusts

A Qualified Personal Residence Trust (“QPRT”) is a low risk and potentially high reward method of transferring a personal residence to beneficiaries at a reduced value for estate and gift tax purposes. The technique tends not to be as popular when interest rates are low, due to the perception that it results in the greatest tax savings only when interest rates are high. However, notwithstanding the current environment of historically-low interest rates, now may be the optimal time for a QPRT, given that home values are still depressed. Furthermore, while advisors for Florida residents may have traditionally shied away from using homestead property in a QPRT for fear of ultimately losing the homestead property tax exemptions, a 98-year lease can ensure that the property retains its homestead status.

Basics of a QPRT

A QPRT generally involves the donor transferring his or her primary or vacation residence to an irrevocable trust. A QPRT can be broken down into two distinct interests: the “QPRT term,” in which the donor retains a right to use the residence rent-free for a specified term of years, and the “remainder interest,” which applies after the QPRT term expires and typically provides that the
residence passes into a further trust for the donor’s spouse, or, if there is no spouse, either outright to, or in further trust for, the donor’s children.

Estate Planning Elements

The primary benefit of a QPRT is that, for gift tax purposes, the transfer of the residence is treated as a gift only to the extent of the  actuarial value of the remainder interest, which is determined under Internal Revenue Service (“IRS”) tables. The gift tax transfer is determined upon the creation of the QPRT, so that if the donor survives the QPRT term, the value of the residence, including any appreciation after it is transferred to the QPRT, is not included in the donor’s estate for estate tax purposes. Thus, a QPRT allows a donor to realize estate tax savings by removing the residence from his or her estate at a fraction of its current value. Unlike some other planning techniques, the QPRT is expressly authorized by the Code and Treasury Regulations.1

The value of the donor’s right to use the residence is based on the donor’s age,2 the length of QPRT term and the valuation rate as determined under § 7520 (the “7520 Rate”) for the month of the transfer. For example, assume a 65-year-old homeowner ransferred his residence, with a value of $1 million, to a QPRT with a 10-year QPRT term in October, 2012. Applying the applicable 7520 Rate
of 1.2%, the value of the donor’s QPRT term is $303,110 and the value of the remainder interest, or the amount of the taxable gift, is $696,890. Thus, using the QPRT allows the donor to generate a 30.31% discount on the value of the residence for gift tax purposes.

The value of the remainder interest is a direct result of the length of the QPRT term. The longer the QPRT term, the greater the ctuarial value of the QPRT term and the lower the amount of the taxable gift. For example, assume the same facts as above, except that the QPRT term is 15 years, rather than 10 years; the result is that the actuarial value of the remainder interest is reduced to 6,800.

There is no required maximum (or minimum) term; however, the donor should be careful to choose a term that he or she is likely to outlive. If the donor dies during the term, the value of the entire property at the time of the donor’s death will be included in his or her estate for estate tax purposes. This would nullify the tax savings that the QPRT was intended to accomplish; however, the result to the donor is the same as if the donor had never created the QPRT.3 For this reason, the QPRT is sometimes referred to as a “heads you win, tails you break even” technique.